April 5, 2016
The past six months have brought a number of significant state and local tax cases with wide-ranging effects on businesses and individuals in the Commonwealth of Pennsylvania. These include cases involving corporate net income tax, the Public Utility Realty Tax Act, and the Local Tax Enabling Act, among others.
This EFlash highlights these cases and touches on their potential implications.
Corporate Net Income Tax:
In November, the Commonwealth Court held that the net loss carryover deduction for corporations violated the Uniformity Clause of the Pennsylvania Constitution. Nextel Communs. of the Mid-Atlantic, Inc. v. Commonwealth, 129 A.3d 1 (Pa. Commw. 2015). The deduction is expressed as a percentage of income, but it is subject to a hard cap in dollars; for example, for 2006 and 2007, the deduction was for “the greater of twelve and one-half per cent of taxable income . . . or three million dollars.” 72 P.S. § 7401(3)4.(c)(1)(A)(ii). Nextel argued that this structure violated the Uniformity Clause because it discriminated against Nextel based upon the size of its business. The majority accepted this argument and awarded Nextel a sizeable refund. Nextel, 129 A.3d at 13. The dissenters agreed there was a violation, but they would have simply struck down the statutory cap. Id., 129 A.3d at 14-16 (Pelligrini, J. concurring and dissenting).
The Commonwealth filed an appeal to the Supreme Court in January. While predicting the outcome of litigation is difficult, the fact that the lower court unanimously agreed that the structure of the deduction violated the Uniformity Clause suggests that the Supreme Court will focus primarily on the appropriate remedy. In a similar situation, the Supreme Court previously held that relief must include a mechanism to remedy past discrimination, such as a refund, a program to collect additional taxes from those who improperly benefited from the illegal structure of the tax, or a combination of the two. See Annenberg v. Commonwealth, 562 Pa. 581, 757 A.2d 338, 349-50 (2000) (decided under the commerce clause).
Corporations that had their net loss carryover deduction capped in prior tax years may wish to consider filing protective refund claims while the Supreme Court addresses the case.
Gross Receipts Tax:
The Supreme Court of Pennsylvania issued an opinion in November rejecting a challenge by Verizon to the application of the gross receipts tax to three aspects of its business: the installation of private phone lines, the provision of directory assistance services, and non-recurring charges for services such as installation, changes to telephone lines and repairs. Verizon argued that these categories of services were not subject to the gross receipts tax because the revenues they generated were not derived from “telephone messages transmitted,” as the statute required. See 72 P.S. § 8101(a)(2). The Supreme Court rejected that argument. Verizon Pa., Inc. v. Commonwealth, 127 A.3d 745, 756-59 (Pa. 2015). Verizon illustrates the principle that old case law can take on a life of its own. Revenues from services such as repairs to phone lines certainly do not appear to be derived from the transmission of telephone messages, but Verizon still lost.
Verizon’s challenge was rejected because the Supreme Court had adopted a very broad test for telephone services under the gross receipts tax over seventy years earlier in Commonwealth v. Bell Telephone Company, 348 Pa. 161, 34 A.2d 531 (1943), and the statute had been amended several times without any change in the language that applied to telephone companies. Verizon, 127 A.3d at 758.
Public Utility Realty Tax Act (PURTA):
PURTA imposes a state-wide tax on the value of real estate held by utilities. 72 P.S. § 8102-A(a). The taxes collected are in lieu of local real estate tax, and are distributed to municipalities. 72 P.S. §§ 8104-A(a). But PURTA does not reach all of the real estate that a utility holds: it only applies to “utility realty,” a defined term that embraces real estate that is used by a utility to furnish utility service and that was not subject to local real estate tax as of April 23, 1968, when the 1968 Pennsylvania Constitution was adopted. 72 P.S. § 8101-A(3). And to the extent that real estate is not taxed under PURTA and not exempt from tax by its terms, local tax authorities remain free to tax that real estate under Article VIII, Section 4 of the Pennsylvania Constitution.
In November, the Commonwealth Court addressed a dispute over whether an intermodal railroad terminal was “utility realty” under PURTA. Lehigh Valley Rail Mgmt. LLC v. County of Northampton Revenue Appeals Board, 126 A.3d 1076 (Pa. Commw. 2015). The property consisted of 107.93 acres in the City of Bethlehem; 22.92 acres held railroad beds and tracks, while 85.01 acres did not. Lehigh Valley, 126 A.3d at 1077. The 85.01 acres that did not contain rails and beds were the focus of the dispute; this land included “aisles” and “staging areas” that were used to shift cargo containers between trucks and trains, an area used to store containers temporarily while awaiting transfer, portions used for stormwater management, and a segment with an office trailer and a parking lot. Id. at 1078. Since the contention was that the disputed property was subject to local tax prior to the enactment of the 1968 Constitution, the court turned to the historical standard, which exempted real estate that was “indispensable” to the railroad’s operations. Id. at 1081(citations omitted).
Applying this standard, the court concluded that the intermodal terminal was the functional equivalent of a switching yard which was exempt under historical precedent. Id. at 1084. The court then remanded so that the trial court could consider an alternative argument that the relevant property was not exempt under PURTA. Id. at 1085. Lehigh Valley offers an illustration of how aggressive local tax authorities have become in testing the limits of their taxing powers. Utilities should consequently anticipate challenges to the local real estate tax exemptions for their properties.
The Local Tax Enabling Act:
In Pennsylvania, the power to tax is vested in the Commonwealth. Local taxes must be authorized by a statute delegating that power to local authorities, which then may enact an ordinance imposing a tax that does not exceed the scope of the delegated power. In December, the Supreme Court decided a troubling case involving a business privilege tax imposed by Lower Merion Township. Fish v. Township of Lower Merion, 128 A.3d 764 (Pa. 2015).
The Local Tax Enabling Act authorizes business privilege taxes. 53 P.S. § 6924.301.1(a)(1). But it also imposes limits on that authority, including a provision that seems to bar local taxes on “leases or lease transactions.” 53 P.S. § 6924.301.1(f). When Lower Merion sought to apply its business privilege tax to a group of landlords, they challenged its ability to do so. A divided Supreme Court rejected that challenge, noting that a tax on the privilege of doing business in a municipality is different from a tax imposed directly on specific transactions. Fish, 128 A.3d at 769-70.
While theoretically consistent with precedent, the reasoning here is not particularly compelling: when all a business does is lease real property, it is hard to see how a tax levied upon gross receipts from that leasing business is not a tax on leases. While Fish may be an unusual situation, it also suggests that limits on the power of local tax authorities under the Local Tax Enabling Act may be read very narrowly in future disputes.
Local Taxes in Philadelphia:
In another local tax case, the Supreme Court issued a taxpayer-friendly opinion in December, holding that the City of Philadelphia is obligated to provide credits to taxpayers who have overpaid their taxes, even if the limitations period for refund claims has expired. City of Philadelphia v. City of Phila. Tax Rev. Board ex rel. Keystone Health Plan East, Inc., No. 19 EAP 2014, 2015 Pa. LEXIS 2988 (Pa. Dec. 21, 2015). While the City sought reargument, that request was denied in February.
The issue arose in 2009 when subsidiaries of Independence Blue Cross completed a federal tax audit and learned that they had understated their deductions and had overstated their income for 2003 and 2004. Because the taxpayers had previously paid Philadelphia’s Business Income and Receipts Tax on the basis of their pre-audit calculation of their federal income, they had overstated their income for local tax purposes as well. Keystone, 2015 Pa. LEXIS 2988 at *2. Under the Philadelphia Code, the taxpayers were required to file amended returns because of the change in their federal income; the taxpayers did so and requested a refund, but the Philadelphia Department of Revenue rejected the refund claim as untimely. Id. at *3-*4.
The taxpayers pursued an administrative appeal, arguing that they fit within the refund limitations period since they were required to file amended returns. While Philadelphia’s Tax Review Board rejected that argument, it concluded that the taxpayers were entitled to credits. Id. at *4-*5. Both the Court of Common Pleas and the Commonwealth Court agreed with this conclusion, and the Supreme Court affirmed. Id. at *15-*16.
Keystone offers individuals and businesses subject to Philadelphia taxes another potential option if a refund claim is time-barred.
Disclaimer: This post does not offer specific legal advice, nor does it create an attorney-client relationship. You should not reach any legal conclusions based on the information contained in this post without first seeking the advice of counsel.
About the Author:
James R. Malone, Jr. is a Principal in the Firm’s Tax Controversy Practice. He represents clients in disputes with federal, state and local tax authorities. Mr. Malone represents clients – including businesses, individual taxpayers, accountants and tax preparers – in both administrative proceedings and in court. Learn More >>